Hi all,
Have tried a slightly new format to force me to get into a “so what?” discussion on these CC summaries. Not sure ZS was the best choice however!
ZS is a 3.5% position for me, and a confusing one. It appeared like a pretty good quarter to me (and appeared to others as “a mess” and “a disaster” 
), revenue growing (less strongly but still up a bunch), expenses flat as % revenue, and raising full year guidance (by a few million). It was a beat and raise quarter, but as we know the stock got pummelled.
I get both the Bear and Bull arguments, and I feel theres a lot of nuance to each of them. However, it is unavoidable that revenue growth is slowing, but I feel any comparison to Nutanix (NTNX) is unfair. NTNX managed to avoid growing at all in a rapidly growing market, whereas ZS is still growing strongly, despite go-to-market execution issues.
The tech is “inevitable” for big business, lots of competition, enterprise sales cycles, “improving pipeline” … clear as mud! ZS is still reasonably expensive from EV/S.
So what? Need to think about this some more. I think ultimately it comes down to timeframes, and whether you believe the CEO or not (re: improving go to market, pipeline).
I’ll post Berts take in this thread once it becomes a bit more public.
cheers
Greg
Q2 2020
My thoughts
This was IMO a pretty good quarter. They increased FY revenue guidance marginally from the previous quarter (from [$405m - $413m] in Q1 to [$414m - $417m] in Q2), expenses are under control as percent of sales despite big sales and marketing spend over the last few quarters. Revenue growth slowed which was probably the big drag on stock price. Or maybe it was bookings, only up
The biggest issue IMO is the revenue slowdown and the extended sales cycles. But this is an enterprise sales company, selling complete security overhauls to big companies, so whaddaya expect? I guess the issue is “they knew that, so why didn’t they sort their go-to-market previously?” which I guess reflects the difficulty of actually scaling enterprise sales.
Sauls board
“But now that the legacy security companies are aware of the threat to their very existence, they will fight tooth and nail…It will be a long struggle (for ZS).”
“Zscaler…tailwind of inevitability… But asking huge enterprises to revamp their entire security systems (=difficult)… I have other companies, growing like mad, without these execution problems (Crowdstrike, Coupa and Datadog).”
Berts take
To be added
Checklist
Q: What is revenue doing yoy?
A: 49.16m, 56.17m, 63.30m, 74.30m, 79.13m, 86.11m, 93.59m, 101.30m {49.1%, 53.7%, 58.8%, 65.2%, 61.0%, 53.3%, 47.9%, 36.3%}
Maybe a bit of seasonality with trailing 12 month growth figures hovering mid-high +50%s?
Q: What are customers doing q-1?
A: According to IR, they only release annually. Thats annoying.
| | Customers | | G2000 |
|:--------------|:----------|:-----|:------|
| July 21, 2019 | 3900 | +20% | 400 |
| July 21, 2018 | 3250 | | |
Q: DBNER?
A: 116% ZS is a bit weird. They’re not really land+expand. It’s more of a big-bang, top-down approach. Theoretically their NER should approach the rate of headcount growth in their customers, unless there’s upsell for new products.
Q: Revenue per customer up or down (either revenue/customers or ARR)?
A: ?? hard to tell until Fiscal 2020 figures released (Q2 21)
Q: Expenses as percent of revenue going up or down (ie, any sign of leverage)?
A: Expenses as percent of revenue:
| | Q3 18 | Q4 18 | Q1 19 | Q2 19 | Q3 19 | Q4 19 | Q1 20 | Q2 20 |
|:--------|:-------|:-------|:-------|:-------|:-------|:-------|:-------|:--------|
| Revenue | 49,163 | 56,174 | 63,298 | 74,302 | 79,128 | 86,108 | 93,590 | 101,268 |
| yoy % | | | | | 61% | 53% | 48% | 36% |
| R&D | 9,907 | 11,480 | 13,186 | 15,071 | 16,499 | 17,213 | 20,271 | 20,706 |
| | 20% | 20% | 21% | 20% | 21% | 20% | 22% | 20% |
| S&M | 29,892 | 32,479 | 36,545 | 38,756 | 45,295 | 49,317 | 59,411 | 61,621 |
| | 61% | 58% | 58% | 52% | 57% | 57% | 63% | 61% |
| G&A | 8,964 | 8,638 | 10,131 | 10,386 | 15,911 | 10,170 | 12,625 | 28,983 |
| | 18% | 15% | 16% | 14% | 20% | 12% | 13% | 29% |
The Q2 20 G&A figure includes a $16.3m one-off ($15m to Symantec) for lawsuits. Adjusting for this: $13,983 (14% revenue)
No real evidence of leverage, everything is pretty flat, but not increasing as % of revenue.
Valuation
EV/SALES TTM
EV/Sales currently at 18.3 since data is end of day
Goal price
3/7 approaching 4/7 with todays (25 Feb) drop.
Historical range
mean 23.319721
min 14.560155
25% 18.386159
50% 21.894606
75% 27.990035
max 35.398673
Last 1000 days data
```
33.77 ¦
32.10 ¦ ?-----?
30.43 ¦ ?-? ?? ??
28.76 ¦ ¦ ?-? ¦
27.09 ¦ ?? ¦ ??
25.43 ¦ ¦¦ ?? ¦
23.76 ¦ ?-??????? ?? ¦
22.09 ¦ ¦ ???? ?? ???? ?-? ¦ ???
20.42 ¦ ¦ ¦ ¦¦¦?-? ?? ¦??
18.75 ¦?--?¦ ?-??? ?? ?? ??
17.08 +? ?? ?????-?
15.42 ¦ ??
```
Definition: CASB - Cloud Access Security Broker. ZScaler provides CASB for inline content. Offline control is provided by partners (MCAS, McAfee etc). ZS internet gateway - blocking Restricted apps. Permitted apps (users allowed, but need more control - not sanctioned apps) - need more control.
eg 1: Permitted apps - Github repositories
- If you want to see changes, need MCAS.
- Block upload of sensitive data - ZS.
- Allow upload to permitted Github repositories, eg: developer network only, need ZS + MCAS.
- Github visibility for mobile users - ZS
- Malware - ZS
eg 2: Sanctioned apps
MCAS actually talks to the cloud app, eg O365, ServiceNow, SalesForce, Box, Dropbox etc., so gets fine-grained information out of that app. ZS sits between your users and the cloud app. So ZS sits closer to the user, MCAS sits closer to the cloud application.
CASB to see what users are doing on the apps themselves. ZS can tell that a user downloaded a 100mb file from SalesForce, but can’t tell you what exactly the user was doing on SalesForce.
CC Summary
Solid Q2 results - tremendous progress in areas… particularly go-to-market.
Revenue: +36% +41% adj - difficult comp due to non-recurring private cloud sale.
Billings: +18% +30% adj
Go-to-market seems to be focus
11% Operating Margins (non-GAAP)
$15m one-time cash payment to settle lawsuits
- adj. FCF = $13m
Anecdotes
European national transportation provider - “scalability and elasticity of cloud critical enabler”
- ZS - only solution capable of scaling from 2gb/s to 100gb/s
- Used Global SI
F500 material sciences ZIA for 57k users. “On-premise security gateway became irrelevant”
F100 healthcare - started with large paid pilot for 10k users 9 months ago. Purchased additional seats + CASB product [GD: whats this? Cloud Access Security Broker, see definition at start] to cover 65k users. First CASB win. [GD: Not quite clear on this. ZS have some CASB functionality, but partner with CASB providers Microsoft MCAS, McAfee, Bitglass, and Proofpoint]
ZPA “fastest growing product line”
G10 oil and gas - 2 years ago ZIA transformation bundle for 145k employees. 200% growth in traffic over 2 years, customer purchase ZPA for >100k users to “replace legacy VPN and secure access to applications in the public cloud”.
Spend increase 700% over 4 years.
Multinational industrial - ZIA business bundle + Cloud firewall for 60k users and ZPA for 40k users. Driven by 1. pursuing local breakout (750 locations) instead of 3 data centers (O365 “overwhelmed” existing security infrastructure), & 2. execute faster M&A and divestitures.
F500 medical testing company - ZIA business bundle and Cloud Firewall for 25k users, local breakouts for 3600! locations. Also purchased ZPA for 8k users to replace legacy VPN.
SASE, Gartner, Zero-trust
Think ZS “most comprehensively meets core architecture of SASE”. SASE since 2008.
ZTNA - renders firewalls etc irrelevant. Well-positioned.
New products
- ZS B2B
- ZS Digital Experience (ZDX)
- CASB [GD: whats this again?]
Go-to-market
“Focussed on improving sales execution”
“remarkable progress in short period of time”
“rolled out a refined, repeatable and scalable sales process”
Key initiatives
- Sales enablement program - consistency and quality of execution
- AI-based tools and systems to provide visibility into sales activities, key go-to-market metrics [GD: ai, schmay-eye].
- Deepened sales leadership
Two major mid-year sales kick offs, 1 Europe, 1 US.
Customer engagements up “significantly”, “more CXO meetings”
“Quality and volume of pipeline is growing”
“we have been integrating our solution with technology leaders and creating go-to-market leverage with deeper field engagements with their sales organizations.”
eg: Integrated with CrowdStrike, selling to respective customer bases.
Microsoft Partnership “growing stronger”. Training MSFT security professionals on integrated solution. ZS Microsoft Security 2020 partner finalist.
Working closely with VMWare and SilverPeak to secure SD band deployments.
Finances
| - | | |
|:----------------|:------------|:---------------------------------------------------------------------------------------|
| Revenue | $101.3m | +8% qoq 36%yoy. $2.3m non-recurring last Q2, excl this:+41% |
| --- US | 51% | |
| --- EMEA | 40% | |
| --- APJ | 9% | |
| Billings | $135.4m | +18% yoy. "large upfront billing of $11 million in Q2 of 2019." **Adj. billings +30%** |
| RPO | $609m | +32% yoy |
| Contract terms | 1-3 years | billed 1 year in advance |
| DBNRR | 116% | vs 120% qoq, so drop. Issue? They say due to bigger upfront deals |
| GM | 82% | +2% yoy +1% qoq. Think 80% good target |
| Opex | $71.9m | +44% yoy +17% qoq R+D & S+M |
| | 71% revenue | vs 67% yoy |
| Headcount | | |
| S&M | $49.4m | +49% yoy, +1% qoq - higher compensation, building teams, new sales guy |
| R&D | $14.8m | +33% yoy, -4% qoq. Decrease due to higher capitalisation of software dev costs. |
| G&A | $8.1m | -5% qoq, +36% yoy. Excludes. **$16.3m in litigation ($15m to settle symantec)** |
| OpMargin: | 11% | vs 13% yoy |
| NetIncome | $12m | |
| EPS | $0.09 | |
| Cash and equivs | $385m | |
| FCF | $2m | Nb: $15m symantec payment - one off|
Guidance
| Guidance | | |
|:-----------|:---------------|:-----------------------------------------------------------|
| Q1 revenue | $105-107m | 33-35% yoy |
| Op Profit | $1m-$3m | Increasing sales investments in Q3 |
| EPS | $0.01 to $0.03 | |
| Shares | 139m | |
| FY2020 | $414m - $417m | +37-38% yoy |
| Billings | $512m-$517m | +31-33% |
| OpProfit | $16-$18m | Note: Zenith Live conferences in EMEA and US ($5-$6m cost) |
| EPS | $0.14-0.16 | |
| Shares | 139m | |
“We are stepping up our sales and marketing investments in order to build the foundation for long-term growth. In addition, we’ll increase investments in our technology platform and cloud infrastructure.”
“As you model billings, I want to remind you that historically, Q2 and Q4 have been our strongest billing quarters with the sequential declines in Q1 and Q3 quarters respectively. For the year, excluding the $11 million of upfront billings in Q2 of 2019, our updated billings guidance for the fiscal year implies 35% to 37% growth.”
Free cash flow
Extraordinary items
- Symantec payment
- Additional spend for tenant improvements re: shifting hq
Total: ~$22-$25m payments.
Therefore: FCF margin down 1 point vs operating margin. Longer-term, FCF should be higher.
Jays 4 key points
- architecture matters for a cloud security platform that must sit in line to inspect all traffic for policy enforcement. We believe we’re the best architecture with over 10 years of operational experience to run a massive cloud, which is an enormous barrier to entry.
- Two, with multiple tailwinds such as Office 365, SaaS adoption, SD WAN and app migration to public clouds, we believe the market is coming to us.
- Three, we are in early innings of the cloud journey. We’re disrupting a $20 billion TAM with ZI and ZPA. With recently announced Zscaler B2B and ZDX we believe we will expand our addressable market significantly.
- with expanded go-to-market leadership in place, we are building a sales machine that can deliver world-class execution and sustainable long-term growth.
Question-and-Answer Session
- Business decelerating, needs to accelerate to meet guidance. Enabling, improving go-to-market. We’re confident because 1. we can measure sales engagement, seeing far better than we used to have. 2. Volume/quality of pipeline going up.
- Average duration (as impacts billings) came down a bit (because of big public sector payment), but is around 12 months, hasn’t changed much yoy or qoq.
- SD-WAN partners, mainly VMWare Velocloud, Cisco Viptela, Silver Peak. In those deals we’re the preferred security choice. They don’t try to build security in the box.
- Beat on operating margin was related to beat on revenue, and lower operating expenses related to headcount. Expect to step up go-to-market investments. Got some big expenses, user conferences and Sales conferences. Expect 60% RSM head count growth yoy (Regional Sales Manager?).
- Accelerate RSM growth in back half, today behind on sales plan, but leaders trained in hiring and training, so confident of getting to 60%. Added Regional VPs. RVPs, Area VPs and GOVPs +80% of expanded target. Need that leadership before RSMs. Attrition was also high, but feel that is behind us.
- Competitive landscape, haven’t seen much impact. Churn down yoy. Discount “pretty stable”, Average ARR of >3k users ~400k. Want to stay focussed on sales execution.
- Net retention rates - ZIA customers buy for entire user base [GD: so net retention tends to zero for ZIA if they buy again within the year]. We don’t put a lot of importance in it.
“Also basically the mix between new and upsell. In the quarter, we saw in the mid-range of what we’ve seen in prior quarters. It’s 60% or 50% new in the quarter is basically in the mid-range of that. Prior quarter our net retention rate was 120% and we called out that that was basically 50% new. So it’s going to vary and we’ve talked about, it’s a metric you should look at, but it’s not one that we put a whole lot of importance to.” [GD: didn’t quite get this… neither did the next analyst
- NetScope → see them in CASB, but we have integrated platform, don’t really see them in our markets.
- Symantec announcements, any increase in displacements of Symantec Blue Coat? “lot of additional interest” [GD: so no…]. Good opportunity for us.
- ZDX, ZB2B, general availability pushed out a quarter? No, said before beta testing for Q4 rollout. On target. Early engagement B2B is really good. “Ideal opportunity for us”. But… need “demand creation because people don’t even know this kind of thing exists”. ZDX “tons of interest”. Don’t expect a lot of contribution in Q4 but expect to help in Fiscal 21+. Good plans in place to sell, incubation process for sales to learn/rollout proper training.
- 60% growth in RSMs, on full quota after 12 months (not 100% capacity). Expect positive impact in Fiscal 21 [GD: thats at least a year away, perhaps the source of worry?]. Expect increased sales productivity as they get ramped. Bulk of margin impact this year, better margins in Fiscal '21.
- Whats Dali bring (to larger deals)? Didn’t have process and disciple to take it to large scale. Spending time to make people get up to speed. Better selling methodology [GD: doesn’t sound like the market is coming to them…? I guess what this means is that the move to cloud means the market needs their kind of solution, not that the market is beating down their door specifically]
- Mentioned pipeline quality improvement - quality = understand stakeholders, architectural workshops on networking side.
- Geographical US outperformed - EMEA leadership transition “outstanding”, APJ +56% yoy. EMEA +39% yoy. Americas +40 yoy adjusted for the non-recurring purchase last year.
- SDWAN - Fortinet, coexisting or competitive. Engagement security conscious large companies, dont see a lot of SDWAN. Cisco, VMWare, Silverpeak? Some overlap, see as complementary.
- Sales cycles changes - expect shortening of sales cycles over time, but at the moment 3-4 months for smaller accounts, 6-12 months for larger deals.
- Large deal execution improving? We do very well. Evangelism - becoming less, execution “Getting good”(sic). Lots of stakeholders, complex sales process. Enablement process is helping, feel “more confident” in handling larger deals.
- Large deal sales - sales force ok? Hiring across the board. Big market opportunity.
